Fitch Rates Missouri Development Finance Board's $96MM Annual Appropriation Bonds 'AA+'

NEW YORK--()--Fitch Ratings assigns an 'AA+' rating to the $96.45 million Missouri Development Finance Board (MDFB), state of Missouri annual appropriation bonds (Fulton State Hospital project) series 2016.

The bonds are expected to be sold through competitive bid on or about Dec. 6, 2016.

The Rating Outlook is Stable.

SECURITY

The bonds are special obligations of the MDFB, payable from annual state general assembly appropriations. As such, they are rated one notch below the state's Issuer Default Rating (IDR).

KEY RATING DRIVERS

Missouri's 'AAA' IDR reflects a low long-term liability burden, historically conservative financial operations and a broad and diverse economy. Missouri has a long record of maintaining fiscal balance through spending restraint. The governor has strong constitutional authority to withhold appropriated funds as needed, a power frequently utilized to deal with intra-year revenue volatility. Additional financial flexibility is provided by a budget reserve fund (BRF) equal to 7.5% of net general revenues; notably, reserve funds were not drawn down during the Great Recession.

Economic Resource Base

Missouri's economy is broadly diversified and similar in makeup to that of the nation, providing a strong revenue base, although the state's economic growth has slightly lagged national trends, particularly since the Great Recession. Fitch anticipates the economy will continue to grow, but at a modest pace and likely below national trends. The state's population is slightly older than the U.S. average and growing more slowly than the national trend.

Revenue Framework: 'aa' factor assessment

Fitch expects that Missouri's revenues, primarily income and sales taxes, will continue to reflect the depth and breadth of the economy, but also its slower pace of growth. The state has complete independent control over its revenues, with the ability to override constitutional revenue limits within combined executive and legislative control.

Expenditure Framework: 'aaa' factor assessment

The state maintains ample expenditure flexibility, with a low burden of carrying costs for liabilities and the broad expense-cutting ability common to most U.S. states. As with most states, Medicaid remains a key expense driver, but one that Fitch expects to remain manageable.

Long-Term Liability Burden: 'aaa' factor assessment

Missouri's long-term liability burden is low and well managed. Debt issuance is carefully monitored, with all outstanding debt managed by the Office of Administration or the Missouri Department of Transportation. The state has generally maintained a commitment to full actuarial funding of its pension systems, contributing to relatively low unfunded liability levels.

Operating Performance: 'aaa' factor assessment

Missouri remains extremely well positioned to deal with economic downturns, with very strong gap-closing capacity due to its control over revenues and spending and a demonstrated willingness to take timely budgetary action. The state tends to rely on its significant expenditure control to deal with budgetary stress. As revenues recover, Missouri restores many of those cuts.

RATING SENSITIVITIES

FUNDAMENTAL CREDIT CHARACTERISTICS: The state's ratings are sensitive to shifts in fundamental credit characteristics, including Missouri's stable economic profile, proactive and conservative financial management, and very manageable long-term liabilities.

APPROPRIATION-BACKED BONDS: The ratings for the various appropriation-backed bonds issued on behalf of the state are sensitive to changes in the state of Missouri's 'AAA' IDR, to which they are linked.

CREDIT PROFILE

Revenue Framework

Missouri's income tax serves as the state's primary revenue source, accounting for nearly two-thirds of general fund revenues. The sales tax is the next largest component and together these economically sensitive taxes provide the basis for the state's revenue framework.

Historical revenue growth, adjusted for the estimated impact of policy changes, has been essentially flat on a real basis over the last 10 years. Sharp declines during the recession offset strong gains in the years leading into it. Since then, revenue growth has generally been slow. Fitch anticipates the long-term trend for revenue growth will be in line with historical performance.

Missouri has no legal limitations on its ability to raise revenues through base broadenings, rate increases, or the assessment of new taxes or fees. The Hancock Amendment imposes strict limits on revenue-raising measures. But the restrictions can be overridden with a gubernatorial emergency declaration stating a specific dollar amount to be funded and approval by a two-thirds vote of each legislative chamber.

Expenditure Framework

As in most states, education and health and human services spending are Missouri's largest operating expenses. Education is the larger line item, as the state provides significant funding for local school districts and the public university and college system. Health and human services spending is the second largest area of spending, with Medicaid being the primary driver.

Spending growth, absent policy actions, will likely be slightly ahead of revenue growth driven primarily by Medicaid, requiring regular budget measures to ensure ongoing balance. The fiscal challenge of Medicaid is common to all U.S. states and the nature of the program as well as federal government rules limit the states' options in managing the pace of spending growth. In other major areas of spending such as education, Missouri is able to more easily adjust the trajectory of growth since it does not retain responsibility for direct service delivery.

Education funding has been a source of contention and a lawsuit on its equity and adequacy yielded a new funding formula. A new education foundation formula passed the legislature in 2006 (and was modified in 2010) based on targeted spending per pupil to resolve equity issues. The formula was expected to be fully phased in by the 2012-2013 school year, but the state has repeatedly delayed full funding.

Missouri retains ample expenditure flexibility. While Medicaid costs are somewhat beyond the state's ability to materially change given federal requirements for the program, the state's carrying costs for debt and retiree liabilities are minimal. Like most states, Missouri's operating budget (outside of Medicaid) goes largely towards funding of services rather than direct service delivery allowing the state to shift costs to lower levels of government in times of fiscal stress without immediate effects on service delivery.

Long-Term Liability Burden

Missouri maintains a modest long-term liability burden that should remain a low burden on resources. Per Fitch's '2016 State Pension Update' report, dated November 2016, the state's total net tax-supported debt and unfunded pension liabilities of $7.9 billion made up just 3.1% of 2015 personal income compared to the 50-state median of 5.1%.

Debt levels reflect borrowing for transportation needs, including bonds issued under voter-approved Amendment 3 and federal grant anticipation revenue vehicle bonds. Approximately 60% of outstanding net tax-supported debt has been issued for transportation purposes. General obligation (GO) bonds constitute only a small amount of outstanding debt, with the remainder consisting of appropriation-supported issues. The state has used multiple entities and mechanisms to issue appropriation debt, which is used primarily for state facilities and economic development.

The Missouri State Employees' Retirement System (MOSERS) and the Missouri Department of Transportation and Highways Patrol Employees' Retirement System (MPERS) are the state's primary retirement systems. MOSERS includes the Missouri State Employees Plan that represents the bulk of the liability. The liability for a separate judicial plan is immaterial. The state consistently funds its actuarially calculated annual determined contribution for the MOSERS and MPERS plans. The state also makes modest contributions towards the Missouri Public School Retirement System for a group of state employees who remain part of that system. The contributions have consistently been at actuarially determined levels.

Pension reform enacted in 2010 made substantive changes for new employees but did not materially affect the liability, as current employee and retiree benefits were largely unchanged. Employees hired after Jan. 1, 2011 have been required to make 4% contributions and face a higher retirement age.

Operating Performance

Missouri's ability to respond to cyclical downturns rests with its superior budget flexibility. The broad, but slow-growth, economy allows the state to gradually restore that flexibility once utilized. Missouri typically responds to budgetary stress with spending restraint, which can include expenditure deferrals. As revenues recover, the state restores prior year cuts and thereby restores flexibility for future downturns. Missouri also maintains a rainy day fund and the state's practice has been to keep that fund intact; it has not been accessed since the early 1990s.

Missouri technically has the independent ability to raise significant revenues, but the Hancock Amendment creates a procedural and political hurdle that makes recurring revenue actions unlikely. Substantial income tax cuts enacted in 2014, which are being implemented over several years, limit fiscal flexibility given the constraints posed by the Hancock Amendment. Once fully implemented, the legislature estimates a baseline annual loss of $620 million in personal income tax revenues, absent any economic growth. This $620 million represents a substantial 10% of fiscal 2014 personal income tax collections and 7.7% of net general revenues for that year.

Positively, the legislation includes revenue triggers to delay implementation of reductions if prior year revenues weaken but the triggers could fail to prevent inopportune revenue reductions. Specifically, the legislation requires that prior year net general revenue collections exceed the highest level of collections in any of the three years before that year by at least $150 million before each new phase of the tax reductions can go into effect. The trigger does not account for sharp midyear revenue declines as witnessed during the recession and even in fiscal 2014. If the legislation were effective in fiscal 2014, the tax cut would have been implemented, even as state revenues declined.

Missouri's conservative financial management and strong executive budgetary powers to restrict spending allow governors to be proactive in making prudent fiscal choices. Voters recently approved a legislatively referred constitutional amendment that gives the legislature the ability to override mid-year executive spending restrictions. Fitch does not view this as a fundamental weakening of the state's budgetary controls as the governor retains ultimate ability to ensure fiscal operations remain balanced.

Throughout the Great Recession, Missouri made significant expenditure cuts, particularly in education spending. With fiscal recovery, the state has restored many of the recessionary cuts. Missouri has a long record of full actuarial contributions to its major pension systems, and the state maintained that commitment through the last downturn.

The state also maintains a budget reserve fund set at 7.5% of net general revenues that provides an additional measure of fiscal flexibility, though one that has very rarely been utilized for budget management. Missouri mainly uses the fund as a liquidity tool for intra-year borrowing to eliminate the need for external cash flow notes issuance. Accessing the BRF for budgetary needs has similar procedural hurdles as set out in the Hancock Amendment regarding revenue raising. Missouri has only accessed the BRF once, in 1993 to deal with flood expenses, for budgetary needs.

CURRENT DEVELOPMENTS

Fiscal 2016 general revenue collections ended short of the 2.8% growth forecast, which the state addressed primarily through expenditure controls. Individual income and sales and use tax collections grew but corporate tax collections were approximately $70 million below estimate. The administration attributes the decline to effects of legislative changes in corporate tax policy enacted several years ago that altered how multi-state corporations apportion their tax bases. Corporate tax collections are down $35 million (24%) through the first four months of fiscal 2017 as well. But individual income tax collections (the largest source of general revenues) are up 5%, with particularly robust 6.4% growth in withholding.

The state's fiscal 2017 budget does not include any significant tax or spending policy changes. Medicaid remains a significant cost driver with pharmacy costs, particularly for specialty drugs, and enrollment growth the leading causes for an approximately $300 million increase in general revenue funds appropriations. Total budgeted general revenue spending is approximately $9 billion.

Education spending is up modestly with a $71 million increase in K-12. This is the fourth consecutive budget with increased K-12 state spending. Despite the increases, funding remains short of the target laid out within the foundation formula adopted by the state several years ago. The legislature overrode a gubernatorial veto earlier this year to enact a bill that caps growth in the foundation formula and closes the gap in fiscal 2017 considerably to just $48.2 million from $400 million to $500 million under the prior calculation. While the foundation formula does not set a legal mandate for the state to budget to, it does set a policy target that opens the state up to political pressure to increase spending.

The budget also includes full appropriation for debt service on outstanding debt associated with the stadium that formerly hosted the St. Louis Rams, despite some political opposition following the team's relocation. Bond proceeds were used in 1991 and 1993 to construct a stadium for the National Football League's (NFL) St. Louis Rams franchise. Earlier this year the NFL announced an immediate relocation of the team to Los Angeles. The bonds fully mature in August 2021 and Fitch views the bonds (issued by the Regional Convention and Sports Complex Authority, or RCSCA) as appropriation-backed debt of Missouri. Any failure to appropriate for the bonds would trigger negative rating action for the bonds, other appropriation-backed and GO debt, and the state's IDR.

Date of Relevant Rating Committee: April 25, 2016

Additional information is available at 'www.fitchratings.com'.

In addition to the sources of information identified in the applicable criteria specified below, this action was informed by information from Lumesis and InvestorTools.

Applicable Criteria

U.S. Tax-Supported Rating Criteria (pub. 18 Apr 2016)

https://www.fitchratings.com/site/re/879478

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Contacts

Fitch Ratings
Primary Analyst
Eric Kim, +1-212-908--0241
Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Douglas Offerman, +1-212-908-0889
Senior Director
or
Committee Chairperson
Laura Porter, +1-212-908-0575
Managing Director
or
Media Relations
Elizabeth Fogerty, +1-212-908-0526 (New York)
elizabeth.fogerty@fitchratings.com